Banking on words

It is possible for a perfectly sound financial entity to get damaged by rumour-fuelled loss of confidence, especially when in financial markets confidence seems as scarce as a money-making mortgage-based derivative. RBI and Sebi, whose statements were quick and forthright after ICICI witnessed some panicky withdrawals, would have had this on their mind. Just as financial bets in good times can develop tenuous connections with reality so do financial panics in bad times. Regulators have frequently, or rather almost always, failed to spot over-risky good time bets, but many of them have a better record in responding to bad times. RBI, for example, gave a fairly good account of itself when four years back the Global Trust Bank actually seemed like turning into a private banking horror story. When the bank seemed implosion-ready RBI arranged for shotgun takeover of Global Trust by Oriental Bank of Commerce. Had RBI then worried about procedure and multiple bids and scrutiny, Global Trust would have failed, some other financial firms would have been hurt and a general loss of confidence would have been unavoidable. When real, financial scare stories need quick remedy; when rumoured, they need quick rebuttal.

This is very important to remember as we digest the lessons of the US financial crisis. Hank Paulson and Ben Bernanke have not spent too much time cogitating about finer points, like how to really make investment bankers feel miserable, they have been learning while doing and they have clearly said stemming the loss of confidence is their first and most important job. All debates about all other aspects of the bailout are in a sense secondary 8212; they become important only after confidence recovers.

India8217;s current financial immaturity spares it the larger challenges but as its economy grows, its financial architecture will have to become more sophisticated and, like it or not, there8217;ll be financial instability sometimes. That8217;s why it is important that we sort out financial regulation structure now 8212; who monitors whom and how. The US crisis has taught us that pages of rules are a worse form of regulation than asking for commitment to broad, definable principles. That8217;s a good starting point for rule-loving Indian regulators.